Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but the fact that you suffer a permanent loss of capital. “. It’s only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Mostly, Gold Entertainment, Inc. (NASDAQ: GDEN) is in debt. But the real question is whether this debt makes the business risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
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What is Golden Entertainment’s net debt?
The image below, which you can click for more details, shows Golden Entertainment owed $ 1.13 billion in debt at the end of March 2021, a reduction from $ 1.33 billion. US over one year. On the other hand, it has $ 145.4 million in cash, resulting in net debt of around $ 982.7 million.
How strong is Golden Entertainment’s balance sheet?
The latest balance sheet data shows Golden Entertainment had $ 141.9 million in liabilities due within one year and $ 1.30 billion in liabilities due thereafter. On the other hand, it had US $ 145.4 million in cash and US $ 15.1 million in receivables due within one year. It therefore has liabilities totaling US $ 1.28 billion more than its cash and short-term receivables combined.
When you consider that this shortfall exceeds the company’s US $ 1.24 billion market capitalization, you may well be inclined to take a close look at the balance sheet. Hypothetically, an extremely high dilution would be necessary if the company were forced to repay its debts by raising capital at the current share price.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Low interest coverage of 0.021 times and an unusually high net debt to EBITDA ratio of 8.1 hit our confidence in Golden Entertainment like a punch in the gut. The debt burden here is considerable. Worse yet, Golden Entertainment has seen its EBIT reach 96% over the past 12 months. If profits continue to follow this path, it will be more difficult to pay off this debt than to convince us to run a marathon in the rain. When analyzing debt levels, the balance sheet is the obvious starting point. But it’s future profits, more than anything, that will determine Golden Entertainment’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Golden Entertainment has recorded free cash flow of 72% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
To be frank, Golden Entertainment’s interest coverage and track record of (not) growing its EBIT makes us rather uncomfortable with its debt levels. But on the positive side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. We’re pretty clear that we consider Golden Entertainment to be really rather risky, due to the health of its balance sheet. We are therefore almost as wary of this stock as a hungry kitten falls into its owner’s fish pond: once bitten, twice shy, as they say. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. Be aware that Golden Entertainment shows 2 warning signs in our investment analysis , you must know…
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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